Before starting a social enterprise

Document category

Documents

Setting up a charity or social enterprise

What is a social enterprise?

The term “social enterprise” describes the purpose of a business, not its legal form. There is no commonly agreed definition of “social enterprise”, but in general terms, social enterprises are businesses which exist to pursue social and environmental objectives, rather than to realise profit for owners or shareholders. Profit, better called "surplus", is generated but rather than being distributed to the owners of the business it is used for wider social benefit by being reinvested in the business or in the wider community.

Social enterprises operate in a wide variety of sectors but are particularly prevalent in areas such as social care, health, housing, education, environmental protection and regeneration. Some are household names, but the majority are much smaller and operate at a local community level.

But charities exist to pursue social goals for the public benefit. Why would I set up a social enterprise instead of a charity?

Many social enterprises are charities. Charities can trade to pursue their public benefit purposes and many do so very successfully. However, being a charity doesn't suit all social entrepreneurs. Some forms of social enterprise allow the people who run them to combine social purposes with a limited reasonable investment return and also direct management control. This is not always possible with a charity. The board members of those social enterprises can be remunerated (unlike most charity trustees) and social enterprises can, in some forms, have shareholders able to receive limited dividends. Charities are more regulated, but in return receive tax privileges unavailable to other social enterprises.

If social enterprises trade to generate profit for their owners, then aren't they just ethical businesses?

There is no precise definition of either term so there is an overlap. Where ethical or social businesses exist to sell goods and services in an ethical way, social enterprises exist to re-invest profit back into their businesses to help them pursue their social goals. Each can have characteristics of the other and the terms may be used interchangeably in practice.

What legal forms might social enterprises take?

Social enterprise is a descriptive term for the range of businesses pursuing social goals rather than a legal form in itself. There are various legal entities that may operate as social enterprises. These include community benefit societies, co-operatives, community interest companies and in some cases commercial form companies limited by shares. The most common form for charitable social enterprises is the company limited by guarantee. The community interest company, or CIC, is a type of company which was specifically created as a vehicle for social enterprise. A CIC is set up for specified community benefit purposes and it is legally obliged to pursue this mission. It cannot be privatised or distribute capital value. To encourage socially focused investment it can distribute some, but not all, of its surpluses.

What are the differences between a CIC and a normal company?

CICs must exist for the community interest and set out that community interest in their constitutional documents. They also have to register with the government's CIC regulator when they are set up and report to that regulator every year, to show that they have been pursuing their community interest. Normal companies, including social enterprises that are companies but not CICs, do not have to report in this way, nor are they required to set out a community interest in their constitutional documents, although in practice most social enterprises do typically express a social purpose in their constitutions.

The other major difference is that a CIC's assets are locked into the business. This is to ensure that they are applied for its social purpose. If the CIC is wound up, its assets must be transferred to another, similarly asset-locked body. The percentage of a CIC's annual profit that it can pay out to its shareholders as dividends is limited. This is so that the majority of its profits are always re-invested in pursuit of its social purpose. If the company is financed by loans where the interest is calculated by reference to the CIC's profitability, then the interest that can be paid to the lender each year is also capped.

Why would I set up a CIC instead of a normal company?

The attraction of CICs is that they allow an entrepreneur to ensure their new business will always operate in the community interest. But unlike a charity, a CIC allows a paid board and the limited payment of dividends. This means the entrepreneur can clearly explain to the public that the business is for the community interest but receive reasonable remuneration and seek equity investment for the social purpose. While less regulated than charities, the CIC form does guarantee that assets and the majority of profits have to be applied to pursue social purposes rather than for the private benefit of shareholders.

What do I need to do to set up a social enterprise?

When setting up a social enterprise, there is a great deal to think about: its social mission, how it will be financed, its legal form and getting the right people involved.

Although not defined by its legal form, the choice of legal form will have a significant bearing on the way the enterprise is established and run. Social enterprises come in all shapes and sizes and there are a variety of issues to consider when choosing the legal form that may be right for your organisation:

1. Safeguarding the chosen social mission

Social enterprises are driven by some form of social improvement, rather than by profit. The social mission forms the very essence of a social enterprise and it must trade with this in mind. The level of protection afforded to the social purpose of your organisation will depend upon its legal form. If protections are not put in place, this purpose can easily be changed. This social mission must be very clear, and must be borne in mind when choosing the appropriate legal form.

2. Sources of funding

A number of forms of finance are available to social enterprises, including grants, debt and equity finance. The types of funding available to your organisation will depend on its legal form.

If your organisation is likely to be dependent on its own surpluses, it is important to consider the tax implications of each legal form before making a decision. For example, charities benefit from a particularly wide range of tax exemptions and benefits.

3. Managing the risk

Social enterprises can be incorporated or unincorporated. Board members of an unincorporated organisation may be personally liable for meeting any liabilities of the organisation in the event of an asset shortfall. Conversely, an incorporated organisation generally has limited liability, meaning that there is no wider liability for the board beyond the assets owned by the organisation. However, unincorporated forms are easier to establish. When choosing a legal form for your social enterprise, it is important to consider the level of risk that will be faced by the organisation and its management team. For example, higher risk activities include employing staff or taking on property

Apart from red tape, is there anything else I need to be aware of?

A new social enterprise will have similar issues to other business start-ups. Among other things it will need finance to buy assets and stock, take on property and staff and start trading. It will also need to comply with the host of regulations that apply to all new businesses from tax to health and safety.

Where can I get further information on social enterprise?

A good place to start may be the decision tool which can be found here. This tool is designed to help organisations find the legal form best suited to them.

If you have any further queries regarding social enterprises or the appropriate legal form for your organisation, take a look at the range of guidance notes available in the customisable documents section of the site, which includes: